Missing the Point of Medicare Reform: Why Drug Reimportation Is BadPolicy

An
updated version of Web Memo # 128 (June 18, 2002) on
reimportation.

As part of the fierce congressional debate on Medicare
prescription drug legislation, some Members of Congress want to
establish a policy to guarantee Americans "cheap" prescription
drugs by allowing them to import drugs subject to the price
controls of Canada and other foreign countries. This is bad health
care policy.

Reimportation of drugs from Canada, or any other country, does
not address the real problems of the relatively small population of
seniors who are without drug coverage.[1] It does not provide
those seniors with a reliable source of coverage, and it avoids the
fundamental problem facing all seniors: that Medicare is unable to
adjust to the changing needs of its beneficiaries. Therefore,
Congress must reform the Medicare program and, in the interim,
should consider targeting assistance to seniors who currently do
not have prescription drug coverage in a way that does not
jeopardize reform.[2]

Besides the fact that reimportation is a distraction from the
real task before Congress-comprehensive reform of the Medicare
program-there are many other compelling reasons why reimportation
is bad health care policy.

Why Drug Reimportation Is Not A Free Trade
Issue
Some congressional advocates of drug reimportation argue that it is
a "free trade" issue. They say this because it would allow
individuals to purchase their prescription drugs at the best
available price. However, one of the fundamental tenets of free
trade is that there is a level playing field and a free market upon
which suppliers of goods and services are able to compete.
Prescription drugs priced in Canada clearly are not based on fair
market value; they do not reflect an equilibrium price between
supply and demand. Therefore, the proposed policy does not create a
truly competitive and level market for pharmaceuticals.

When government is the single or major purchaser of
pharmaceuticals and other health care services, as it is in Canada,
prices are fundamentally distorted. The government leverages its
bulk purchasing power to "negotiate" prices with pharmaceutical
manufacturers. However, since there is only one major purchaser of
these goods and services and no real consumer-based market for
these products, the government retains the ability to dictate a
fixed price with little or no regard for real market prices.

Legislating Perverse Incentives
Reimportation is likely to engender some perverse incentives.
Consider the following two scenarios in reference to Canada:

Pharmaceutical manufacturers would limit or cease to sell
their products to Canada. Pharmaceutical manufacturers
sometimes choose to sell their products at less than market value
because their loss ratio is minimal in smaller markets, like
Canada. However, under reimportation, if the U.S. begins to import
more drugs from Canada, the existing loss ratio in Canada would
increase and earnings in the U.S. market would decrease. To protect
against this increased loss, pharmaceutical manufacturers would
have a direct economic incentive either to limit any surplus sold
to Canada or to stop selling their products to Canada altogether.
As John Calfee, resident scholar at the American Enterprise
Institute, neatly describes the possible affects:

Suppose Canadian drug prices are two-thirds the level of U.S.
prices. Drug companies would face two choices: They could ship the
U.S. supply of their drugs to Canada, reducing their revenue by
one-third. Or they could tell Canadian authorities they will no
longer sell at discounted Canadian prices, reducing their revenue
by less than a tenth-reflecting the smaller market size and lower
Canadian prices.[3]

Many pharmaceutical manufacturers may be more likely to forgo
the smaller Canadian market for the larger market in the U.S.
However, manufacturers would be faced with an additional penalty.
If a pharmaceutical manufacturer were unwilling to sell its
products at the government-determined price, the country could, in
some cases, allow a generic manufacturer to produce and sell a copy
without the approval of the patent holder.[4] This would undermine
intellectual property rights-a serious unintended consequence.

Canada would stop selling to U.S. citizens. If
reimportation was implemented and pharmaceutical manufacturers
continued to sell their products to Canada, the Canadian government
might choose to stop allowing U.S. citizens to "free ride" off
their health care system, especially if supplies were limited by
the manufacturers. If fewer drugs were available to Canadians, and
it is possible that none would be available to American consumers.
This would defeat the entire intent of the policy.

In the end,
regardless of the scenario, the effect of reimportation in all
probability would be the opposite of that intended by its
proponents: Prices would be more likely to increase in Canada than
they would be to decrease in the United States.

Government
Manipulation of the Pharmaceutical MarketplaceSome congressional champions of drug reimportation no doubt
envision their policy as the first crucial step in adopting similar
price control measures in the U.S. market. Based on roughly 4,000
years of economic history, the passion for price controls on goods
and services routinely emerges as a short-term economic policy and,
at least, in the short run, a politically attractive proposal.
Politicians invariably point to opinion polls in which a majority
of respondents favor government caps on prices for various goods
and services, including drug prices.

The inescapable
problem, of course, is that it is no easier to repeal the economic
laws of supply and demand than it is to repeal the physical laws of
gravity and motion. There has never been a system of price controls
enacted that did not lead directly to a shortage of the quality or
quantity of goods and services, including medical goods and
services. Price control strategy is really a supply reduction
strategy. The chief attractiveness of the price control strategy is
that it does indeed achieve less spending on such goods and
services simply by ensuring that there is going to be, as a matter
of public policy, fewer of them available.

In the area of
health policy, a price control regime could have a devastating
affect on the quality of health care that U.S. citizens receive. In
the case of drugs, it would guarantee delayed and limited access to
pharmaceuticals. In countries where government market involvement
is high, there is less access to lifesaving drugs and treatments
than in those countries without government interference.[5]

Even in the U.S.,
several states, through their ever tighter administration of the
Medicaid program, have begun to adopt similar approaches either
through complicated "cost containment" mechanisms (formularies,
pre-authorization, etc.) or by forcing additional discounts from
manufacturers (supplemental rebates).[6] Although these policies
do "control cost," it is still true that the greater the
government's control over the financing and delivery of these
drugs, the greater the risk to an individual's access to
life-enhancing, or even lifesaving, pharmaceuticals.

Government
interference, particularly price regulation, in the pharmaceutical
marketplace has further side effects. Like all such policies, it
results in massive cost shifting. In other words, it imposes
additional costs on those countries, like the United States, that
champion free markets nationally and internationally. The U.S., in
effect, is forced to compensate for other countries' distortions of
the market. In the case of prescription drugs, the United States is
on the receiving end of government-engineered cost shifting. Thus,
the U.S. is almost always paying a greater share of the research
and development costs that go into creating a new pharmaceutical
product. A recent study by the Tufts Center for the Study of Drug
Development found that pharmaceutical manufacturers spend $897
million to develop a new drug and that only an estimated 21.5
percent of drugs that reach human trials (Phase 1) will be approved
for marketing.[7]
It is this crucial investment in research and development that
brings the lifesaving drugs and treatments to the market, and that
is supported by market-oriented countries.

The Case For
Safety FirstIn the end, there still remain significant safety concerns
surrounding reimportation. In several recent testimonies, officials
of the Food and Drug Administration, as well as representatives of
other government agencies, have noted the potential dangers
associated with reimportation, including individual importation,
the purchase of drugs from foreign sources over the Internet, and
counterfeit drugs entering the United States. In testimony on this
subject last year, William Hubbard, Senior Associate Commissioner
for Policy, Planning, and Legislation at the U.S. Food and Drug
Administration, stated:

Currently, new
drugs marketed in the United States must be approved by FDA based
on demonstrated safety and efficacy…. This "closed"
regulatory system has been very successful in preventing
unapproved, adulterated or misbranded drug products from entering
the U.S. stream of commerce. Legislation that would establish other
distribution routes for drug products, particularly where those
routes routinely transverse a U.S. border, creates a wide inlet for
counterfeit drugs and other dangerous products that can be
injurious to the public health and a threat to the security of our
nation's drug supply.[8]

Similar concerns
have been echoed by current Health and Human Services (HHS)
Secretary Tommy Thompson and former Clinton Administration HHS
Secretary Donna Shalala.[9]
Even the representatives of the Canadian government have recently
clarified their position by stating that they could not
guarantee the safety and effectiveness of drugs exported from their
country.[10]
This is especially troublesome as counterfeit drugs entering the
U.S. pose genuine risks.

Conclusion

The problem of
prescription drugs for senior citizens is invariably a problem of
access. It is not price. Indeed, through insurance mechanisms, it
is clear that seniors can get significant discounts on the prices
of both brand name and generic drugs.

Furthermore, the
problem of access to prescription drugs, as virtually every major
study has shown, is confined to a minority of senior citizens.
Reimportation is not a substitute or fallback for comprehensive and
serious Medicare reform: the kind of Medicare reform that would
fully integrate prescription drug coverage into a normal system of
health insurance in which plans offer a variety of benefit packages
to satisfy the needs of consumers.

Members of
Congress should not ask seniors to rely on another country's flawed
health care system for their health and safety. Members should
resist the temptations of a snappy "quick fix" that does not
address the root problems, but only creates others. The complex
Medicare legislation now being considered by the House and Senate
has enough "unintended consequences" already.

[2]Experts from the Galen
Institute and the American Enterprise Institute developed such a
targeted assistance proposal. For more information, see Joseph
Antos and Grace-Marie Turner, "Executive Summary: Prescription Drug
Security Plan," at
http://www.galen.org/news/plan_description.html.

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Some Members of Congress want to establish a policy to guaranteeAmericans "cheap" prescription drugs by allowing them to importdrugs subject to the price controls of Canada and other foreigncountries. This is bad health care policy. The problem ofprescription drugs for senior citizens is invariably a problem ofaccess. It is not price.

Rep. Peter Roskam (R-IL) says it's "a great way to start the day for any conservative who wants to get America back on track."

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